BROOMFIELD, Colo., July 18, 2002 - Level 3 Communications, Inc. (Nasdaq:LVLT) today announced its second quarter 2002 results. Consolidated revenue increased to $750 million from $386 million in the first quarter 2002. Consolidated EBITDA, excluding stock-based compensation expense and non-cash asset impairment charges of $44 million, increased to positive $76 million from positive $51 million for the previous quarter and negative $106 million for the same period last year, which excluded $61 million of non-cash impairment charges. Consolidated Adjusted EBITDA was $102 million for the second quarter, a decrease from $124 million in the first quarter 2002.
The net loss for the quarter was $0.39 per share, or $156 million, including a $76 million gain from debt repurchases and a $102 million gain recognized from the previously announced sale of common stock of Commonwealth Telephone Enterprises, Inc. (CTCO). Excluding the gain from debt repurchases, the net loss was $232 million, or $0.58 per share versus previously announced projections of a net loss per share of $0.70.
"In spite of continuing challenges in the market, we are pleased to have exceeded our previously issued projections for the second quarter," said James Q. Crowe, CEO of Level 3. "I believe our performance is a result of our continued focus on providing high quality services to high quality customers."
Overview
The company's core business consists of communications and information services. The company's non-core businesses include coal mining and toll road operations. On June 18, 2002, the company completed its acquisition of Software Spectrum, Inc., a global provider, marketer and reseller of business software. The company reports separately the financial results of the company's communications business, information services business and other businesses. Included in the information services business segment are the financial results of Corporate Software, Software Spectrum, and (i)Structure.
Communications Business Segment
Second Quarter Communications Business Financial Highlights
| Metric ($ in millions) |
Second Quarter Actuals | Second Quarter Projections(1) |
| Communications Cash Revenue | $301 | $300 |
| Communications GAAP Revenue | $276 | $270 |
| Communications Services Revenue(2) | $244 | $240 |
| Reciprocal Compensation Revenue | $32 | $30 |
| Communications Cost of Revenue | $62 | NA |
| Communications SG&A | $160 | NA |
| Communications EBITDA(3) | $51 | NA |
| (1) Projections issued April 23, 2002. (2) Includes $20 million in termination revenue. (3) Includes $3 million of cash restructuring charges and excludes $44 million of non-cash impairment charges. | ||
Communications Cash Revenue and GAAP Revenue
Communications cash revenue for the second quarter was $301 million. Communications cash revenue is defined as communications GAAP revenue plus changes in cash deferred revenue. Communications cash revenue includes upfront cash received for dark fiber and other IRU sales that are recognized as GAAP revenue over the life of the contract.
Communications GAAP revenue for the second quarter was $276 million, versus $278 million for the previous quarter. Included in total communications GAAP revenue was $244 million of communications services revenue and $32 million attributable to reciprocal compensation revenue. Of the $244 million of communications services revenue during the second quarter, $20 million was related to termination revenue, versus $39 million in termination revenue recognized during the first quarter.
Termination revenue is recognized when deferred revenue is accelerated as a result of customers disconnecting services or when customers make termination penalty payments to Level 3 to settle contractually committed purchase amounts that they no longer expect to meet.
Consistent with the company's focus on more established companies with substantial communications services needs, the company had approximately 1,600 customers at the end of the quarter - down from approximately 1,775 as of the end of the first quarter. Approximately 69 percent of the customer base currently purchases more than one Level 3 service.
"Our growth in recurring communications revenue during the quarter was primarily fueled by incremental sales to existing customers," said Kevin O'Hara, president and COO of Level 3. "Our IP services and our dial-up access business were the strongest contributors to our growth during the second quarter, as was the case for the first quarter 2002."
Cost of Revenue
Communications cost of revenue for the second quarter 2002 was $62 million, resulting in a 77 percent gross margin, versus a 76 percent margin in the first quarter 2002 and 48 percent in the same period last year.
Selling, General and Administrative Expenses (SG&A)
Excluding restructuring and impairment charges, communications SG&A expenses were $160 million for the second quarter 2002, versus $170 million for the first quarter 2002, and versus $233 million for the same period last year. These decreases are a result of the company's continuing cost management initiatives. SG&A expenses for the second quarter 2002 exclude $47 million in restructuring and impairment charges, consisting primarily of non-cash impairments to real estate assets and inventory. SG&A expenses for the second quarter 2001 exclude $101 million in restructuring and impairment charges. The total number of employees in the communications business was approximately 2,950 at the end of the second quarter.
Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA)
EBITDA from the communications business was positive $51 million for the second quarter, versus positive $42 million for the previous quarter and negative $115 million for the same period last year. EBITDA for the second quarter 2002 includes $3 million in cash restructuring charges, and excludes $53 million in stock-based compensation expense and $44 million in non-cash asset impairment charges. EBITDA for the second quarter 2001includes $40 million in cash asset impairment and restructuring charges and excludes $61 million in non-cash asset impairment charges.
"Our communications EBITDA margin increased to approximately 18 percent this quarter from 15 percent for the previous quarter, primarily as a result of our continued focus on cost containment," said Sureel Choksi, CFO of Level 3.
Consolidated Capital Expenditures
Consolidated gross capital expenditures for property, plant and equipment were $81 million for the quarter. However, reported or net capital expenditures were negative $25 million for the second quarter, versus positive $53 million during the first quarter, primarily as a result of the final payments made with respect to several large construction contracts at costs that were below previously estimated and accrued amounts. During the second quarter, the company closed-out contracts with contractors that resulted in net reversals of previously reported capital expenditures of $106 million. Capital expenditures for the second quarter include approximately $5 million for the information services and other businesses.
Network Highlights
Level 3 now offers services in 69 markets, 57 North American markets and 12 European markets. The company has local fiber networks in 36 markets and has constructed approximately 937,000 local fiber miles to date.
The company recently began offering services in three new European markets: Madrid, Karlsruhe, and Cologne. The company expects to begin offering services in Geneva, Milan, Stockholm and Zurich by the end of the third quarter 2002.
Information Services Business Segment
Revenue
Information services revenue includes the company's (i)Structure, Corporate Software and Software Spectrum subsidiaries. Information services revenue was $447 million for the second quarter 2002, representing a 459 percent increase over the previous quarter. This increase is a result of the seasonality of Corporate Software's business, better than expected performance for Corporate Software during the second quarter, the inclusion of the results of Corporate Software for the entire quarter, as well as the acquisition of Software Spectrum, Inc. The results of Software Spectrum are consolidated with Level 3's results beginning June 18, 2002, when the company completed the acquisition of Software Spectrum. Software Spectrum contributed $124 million of revenue for the second quarter. Going forward, Corporate Software and Software Spectrum will conduct business under the name Software Spectrum.
The total number of employees in the information services business was approximately 3,375 at the end of the second quarter.
EBITDA
EBITDA, excluding stock-based compensation expense, from the information services business was positive $18 million for the second quarter, compared to positive $6 million for the previous quarter and positive $4 million for the same period last year. The significant improvement in EBITDA was primarily a result of the inclusion of the results of Corporate Software for the entire quarter, seasonality and higher than expected revenues.
"We are pleased to have completed our acquisition of Software Spectrum during the second quarter," said Crowe. "Level 3 is now one of the world's largest resellers of business software. In the coming months, we will be integrating Software Spectrum's operations with those of our recently acquired Corporate Software subsidiary. The combined companies have a global reach and a customer base that includes the majority of the Fortune 500 companies."
Other Businesses
Revenue
Revenue from the company's coal mining business and its interest in California Private Transportation Company (CPTC) was $27 million for the second quarter 2002, versus $28 million for first quarter 2002 and $27 million for the same period last year.
EBITDA
EBITDA from the company's coal mining business and its interest in CPTC was $7 million for the second quarter compared to $3 million last quarter and $5 million for the same period last year.
Consolidated Results
Working Capital and Cash Flow
Consolidated working capital requirements were approximately $57 million during the second quarter. Working capital requirements were higher than expected as a result of the acquisition of Software Spectrum. Operating Cash Flow, defined by the company as Consolidated Adjusted EBITDA minus consolidated capital expenditures and consolidated working capital requirements, was negative $36 million for the quarter. Cash consumption from continuing operations, defined by the company as Operating Cash Flow minus net interest expense, was $108 million during the quarter. Level 3 had cash and marketable securities at quarter end of approximately $1.05 billion, or $1.55 billion pro forma for the $500 million investment completed on July 8, 2002.
Stock-Based Compensation Expense
The company recognized $53 million in non-cash expense for stock-based compensation during the quarter. The OSO Program represents the principal component of the company's stock-based compensation. This expense is accounted for in accordance with SFAS No. 123, "Accounting For Stock-Based Compensation."
Since 1998, Level 3 has expensed the value of OSOs and its other stock-based compensation over the respective vesting period. This approach is in contrast to the current practice of most corporations under which conventional stock options are not accounted for as an expense on the income statement.
Under Level 3's plan, OSO awards are indexed to the performance of the company's common stock relative to the performance of the Standard & Poor's 500 (S&P 500) Index.
Depreciation and Amortization
Depreciation and amortization expenses for the quarter were $190 million, a 10 percent decrease over the previous quarter.
Corporate Transactions and Business Outlook
Issuance of 9% Junior Convertible Subordinated Notes
On July 8, 2002, the company completed the sale of $500 million aggregate principal amount of its 9% Junior Convertible Subordinated Notes due 2012. The purchasers were three institutional investors: Longleaf Partners Funds, Berkshire Hathaway Inc., and Legg Mason, Inc. The company plans to use the net proceeds for general corporate purposes, including potential acquisitions relating to industry consolidation opportunities, capital expenditures and working capital.
"We are particularly pleased that Level 3 was able to secure additional investment of this magnitude given the constraints of today's capital markets," said Walter Scott, Jr., chairman of the board. "Perhaps more important is the reputation and stature of the investors who have chosen to partner with us."
"The company is now able, with this additional capital, to better take advantage of acquisition and consolidation opportunities that are available in the communications industry today," said Crowe. "We expect to pursue opportunities that will allow us to add incremental traffic on our existing network, and accelerate increases in our market share from our target customer base."
Debt Reduction
During the second quarter, the company retired approximately $140 million face amount of debt through debt for equity exchanges. The company will continue to evaluate debt reduction opportunities and, when appropriate, expects to pursue such transactions.
Asset Sales
In addition to the $166 million in net proceeds received from the recent sale of common stock of Commonwealth Telephone Enterprises, Inc., the company continues to evaluate the sale of other non-core assets to improve its liquidity position.
As previously announced, the company has reached a non-binding letter of intent to sell its 65 percent interest in California Private Transportation Company (CPTC). If this transaction is consummated, Level 3 would receive approximately $45 million in cash proceeds upon the close of this transaction and the company's consolidated long-term debt would decrease by approximately $140 million. The sale is subject to execution of definitive documentation and approval by appropriate legislative and regulatory authorities. There can be no assurance that the company will complete the sale of its interest in CPTC.
Customer Credit Analysis
On an ongoing basis, the company updates and reviews the creditworthiness of its customer base. The company classifies its customers into one of three categories: creditworthy, moderate risk (customers whose longer term financial prospects may be in question) and at-risk (financially weaker customers who are expected to disconnect services in the near term).
At the end of the first quarter, the company stated that approximately 15 percent of its recurring communications revenue was derived from at-risk customers. During the second quarter, customer disconnects and cancellations from at-risk customers were generally in line with the company's previously announced expectations.
As of the end of the second quarter, the company believes that approximately three-quarters of its recurring communications revenue was from creditworthy customers, and the remaining one-quarter was split evenly between moderate risk customers and at-risk customers.
The company continues to expect disconnects and cancellations to trend down during the second half of 2002, as a result of the improving credit quality of its customer base.
"While we are not immune to negative surprises, and will continue to monitor our customer base carefully, we are pleased with the continued improvement in the credit quality of our customer base," said Choksi. "We believe that recurring communications revenue from at-risk customers will approach normalized levels of approximately 10 percent over time."
Business Outlook
"Previously, we had indicated that we believed our ability to project our results was improving," said Crowe. "However, we are currently seeing mixed signals in terms of the indicators related to revenue and cash flow growth. On the positive side, we experienced a slight reduction in disconnects during the second quarter and expect lower disconnects during the balance of the year. In addition, we are seeing a higher level of sales proposals and request for proposal (RFP) activity than we've seen for several quarters. On the negative side, the events of the past quarter, including the highly publicized turmoil in the communications industry, have contributed to customer uncertainty and longer sales cycles. In addition, the level of new sales completed during the second quarter, particularly for IRUs, was significantly lower than during previous quarters. As a result, our ability to project future results is subject to increased uncertainty."
Third Quarter Projections
Level 3 expects consolidated revenue to be approximately $785 million, including $255 million from the communications business, $500 million from information services and $30 million of other revenue. Approximately $225 million of the communications GAAP revenue is expected to be from services revenue and the balance from reciprocal compensation. Communications GAAP revenue is expected to decline by $21 million from the second quarter, primarily as a result of lower non-recurring termination revenue. Communications services revenue, excluding termination revenue of approximately $5 million, is expected to be $220 million. Communications cash revenue for the third quarter is expected to be $250 million. The quarter over quarter projected decline in communications cash revenue is a result of recent weakness in IRU sales.
| Metric ($ in millions except net loss per share) |
Third Quarter Projections |
| Communications Cash Revenue | $250 |
| Communications GAAP Revenue | $255 |
| Communications Services Revenue(1) | $225 |
| Information Services Revenue | $500 |
| Revenue from Other Businesses | $30 |
| Consolidated GAAP Revenue | $785 |
| Consolidated EBITDA | $50 |
| Consolidated Adjusted EBITDA | $50 |
| Capital Expenditures | $65 |
| Net Loss per Share | $0.85 |
| (1) Includes approximately $5 million of expected termination revenue. | |
The company expects third quarter Consolidated Adjusted EBITDA of $50 million. The projected decline in Consolidated Adjusted EBITDA quarter over quarter is the result of lower communications cash revenue. Consolidated EBITDA, excluding stock-based compensation expense, is expected to be positive $50 million for the third quarter, of which approximately $40 million is anticipated to be generated by the communications business, $2 million by the information services business and the balance by other businesses. The quarter over quarter expected reduction in information services EBITDA is due to seasonality in Corporate Software and Software Spectrum's businesses. As a result of seasonality, the information services business generally has significantly higher revenue and EBITDA during the second and fourth quarters.
Consolidated capital expenditures for the third quarter are expected to be approximately $65 million. The company expects the net loss for the third quarter to be $0.85 per share.
2002 Projections
The company expects Consolidated Adjusted EBITDA of $400 million for the full year 2002. Consolidated capital expenditures are expected to be approximately $160 million, or $275 million on a gross basis. Working capital requirements are expected to be $225 million for the year. As a result, total cash and marketable securities, excluding restricted cash, are expected to be approximately $1.3 billion at the end of 2002.
The company expects to generate positive Operating Cash Flow during the fourth quarter 2002. For the full year 2002, Operating Cash Flow is expected to be negative $100 million.
Summary
"While there continues to be considerable uncertainty both with regard to the timing of the recovery of the communications industry and our ability to project future results with accuracy, we believe that Level 3 is well positioned to benefit when the recovery occurs," said Crowe. "In the meantime, we remain focused on managing cash flow and preserving our strong cash position. We believe we remain fully funded through free cash flow breakeven and now have $500 million in additional liquidity to pursue opportunities."
Attachments
Attachment 1: Consolidated Condensed Statements of Operations
Attachment 2: Consolidated Condensed Balance Sheets
Attachment 3: Executive Officer Intended Transfers of Company Securities
About Level 3 Communications
Level 3 Communications, Inc. (NASDAQ: LVLT), an international communications company, operates one of the largest Internet backbones in the world, connecting 180 markets in 18 countries. The company serves a broad range of wholesale, enterprise and content customers with a comprehensive suite of services including: Internet Protocol (IP) services, broadband transport and infrastructure services, colocation services, voice and voice over IP services, content delivery and media distribution services. These services provide the building blocks to enable Level 3’s customers to meet their growing demands for advanced communications solutions. The company’s Web address is www.Level3.com.
"Level 3 Communications,” "Level 3," the red 3D brackets and the Level 3 Communications logo are registered service marks of Level 3 Communications, LLC in the United States and/or other countries. Level 3 services are provided by wholly owned subsidiaries of Level 3 Communications, Inc. Any other service, product or company names recited herein may be trademarks or service marks of their respective owners.
Forward-Looking Statement
Some of the statements that we make in this press release are forward looking in nature. These statements are based on management’s current expectations or beliefs. These forward looking statements are not a guarantee of performance and are subject to a number of uncertainties and other factors, many of which are outside our control, which could cause actual events to differ materially from those expressed or implied by the statements. The most important factors that could prevent us from achieving our stated goals include, but are not limited to our ability to: successfully integrate acquisitions; increase the volume of traffic on our network; defend our intellectual property and proprietary rights; develop new products and services that meet customer demands and generate acceptable margins; successfully complete commercial testing of new technology and information systems to support new products and services; attract and retain qualified management and other personnel; and meet all of the terms and conditions of our debt obligations. Additional information concerning these and other important factors can be found within Level 3’s filings with the Securities and Exchange Commission. Statements in this press release should be evaluated in light of these important factors. Level 3 is under no obligation to, and expressly disclaims any such obligation to, update or alter its forward-looking statements, whether as a result of new information, future events, or otherwise.
